Trump's border tax will hurt the economy but not in the way people fear

President Donald Trump.
AP
Economists are worried that President Donald Trump's plan to introduce a so-called border tax on imports could cause a spike in inflation.

The logic here is simple: Lots of goods consumed in the US are made overseas, from Mexico to China. Companies aren't going to eat the tariffs Trump wants to slap on these — and so they'll pass on the higher costs to consumers instead.

But the run-up in prices may not be as sweeping as some fear. It'll apply only in select industries, and it will be a one-time hit.

That doesn't mean this won't hurt the economy. Prices are still going higher, and that could become a drag on demand for suddenly pricier goods, denting consumer spending — even on US-made goods. Consumer spending accounts for more than two-thirds of US economic activity.

For the Federal Reserve, which has to balance its job of controlling inflation with keeping the economy growing, the latter is going to matter more. So, even if prices spike, economists don't expect the Fed to react.

Traders seem to have caught on to this. Expectations for inflation did push Treasury bond yields higher at first. More recently, though, they've retreated — a signal investors are not confident in the recovery's durability.

Part of the newfound hesitancy among bond investors comes from an utter lack of clarity on a potential fiscal-stimulus plan, a major source of recent stock market enthusiasm that has seen major averages hit repeated record highs.

At the same time, the Trump team is talking up the part of its economic agenda that many on Wall Street once tried to dismiss as bluster — a desire to aggressively pull back on existing trade agreements and the treating of allies and trading partners as adversaries.

Dovish Fed

Here's what Deutsche Bank economists Matthew Luzzetti and Aditya Bhave had to say about the tax and its implications for inflation — and Federal Reserve policy by association.

"Although the dollar is expected to strengthen to offset some of the effects of the tax, we estimate that core inflation could rise temporarily by between 1.4% and 2.1%," they wrote in a research note. Core inflation excludes volatile food and energy costs, and Fed officials see it as a good predictor of future overall inflation. "Over time, the impact on inflation should be considerably more limited."

"In terms of monetary policy, the border tax should tilt the outlook in a more dovish direction initially, as the Fed is expected to look through the upfront rise in inflation and focus instead on heightened uncertainty and risks to the economy from tighter financial conditions and weaker real income growth," Luzzetti and Bhave added. "Beyond the initial reaction, the tax could be hawkish for the Fed at the margin, especially if the rise in inflation leads to an increase in long-term inflation expectations."

If his picks make the Fed's composition more hawkish, the central bank might take a more aggressive stance on any border-tax related spike in consumer prices. UBS economist Pierre Lafoucade says the Fed should not have to react in principle because "tax changes are one-off level shifts in prices and output, which the Fed should see right through."

He warns, however: "We are late [in the economic] cycle and the tariff and tariff-like policies act like a demand shock — higher prices and output — which eliminate remaining slack. That reduces the Fed's room for maneuver vis-à-vis its inflation and full employment objectives and the Fed is thus likely to tighten policy at least somewhat relative to a no fiscal policy change scenario."